Without a doubt, the COVID-19 pandemic affected the hotel segment of the real estate market. Based on statistics obtained via Statista, three key indicators from March 2021 show a year-over-year decrease in performance:
Occupancy is down 1.4%
Average daily rate is down 14.5%
Revenue available per available room is down 15.8%
Real estate investors know to use certain metrics when making real estate investment decisions. Metrics such as cap rates (found by dividing the annual net operating income by its current value), net operating income (the amount of money a property earns after taking into account all the expenses), and the gross rent multiplier (the price of a property by its potential gross annual income) are all affected by the decrease in these three key indicators.
This would lead many investors to assume that, despite the ability to pick up hotels right now, they should shy away. However, hotels could be an amazing asset to your real estate portfolio if you have the right strategy – conversion from hotels to apartments. Here’s why.
1: Insidious Housing Shortage
As of April 2021, new housing starts fell 9.5%, and the housing market is 3.8 million homes short of what is needed for demand. That shortage is 52% higher than the shortage in 2018. Additionally, there is a shortage of 3.6 million affordable rental homes.
With numbers like these, it becomes apparent that finding a way to increase housing units in areas struggling with a housing shortage makes sense. Therefore, buying a hotel to transition into apartment units has the potential to make financial sense.
2: Ability to Obtain Seller Financing
Many hotel property owners are eager to sell their hotels. Even though COVID restrictions have been greatly reduced, many hotels are on the verge of collapse and the likelihood that they will be able to recover is slim according to a recent American Hotel and Lodging Association survey. As you can imagine, lenders will be far more stringent over the coming months when lending for a hotel property, which will limit the number of potential qualified buyers.
Because of this, many hotel owners will be willing to offer seller financing. By doing so, they can speed up the sale, offset any potential capital gains tax, and create an instant revenue stream without the hassle of running the hotel in a post-COVID environment. This is good for buyers, especially those who may not fit the criteria for the traditional lending process.
3: Buyers Control the Deal
When sellers want out of a property, the buyer has the opportunity to negotiate the terms of the deal. Controlling the deal allows the real estate investor to negotiate such things as interest rate, maturity date, money down, balloon payments, and more. This often leads to a deal with more favorable financing.
4: Pennies on the Dollar
In many cases, you can find hotel deals for pennies on the dollar, which is far better than the deals currently being found on most multi-family deals. Whether you purchase the hotel property for yourself or wholesale it to other investors, the potential to make money when converting these properties is substantial.
Things to Keep in Mind
As with any deal, not every hotel property makes for the perfect apartment conversion. Here are a few things to keep in mind.
Some hotels, like extended-stay hotels or those with kitchenettes, are more easily converted than luxury hotels that do not already have separate living and sleeping spaces.
Hotels that serve business clientele may have a substantial amount of event and meeting space that will need repurposing.
Older properties may not meet the current residential building codes and will cost more to retrofit.
Always look at the zoning and ordinance. Properties zoned for hotels may not be zoned for multi-family use. Additionally, local ordinances on parking requirements for hotels may differ from that of apartments.
Since units will be small, typically from 200 to 400 square feet, they will appeal to a younger generation. Be sure to buy in areas that would appeal to these renters.
By looking at hotels with conversion in mind, investors may be able to find amazing deals in a commercial space experiencing financial trouble. As always, be sure to do your due diligence and crunch your numbers, but certainly, don’t dismiss hotels without a further glance.